Wednesday, October 07, 2009

The Hideki Gondô rule

In the movie a Taxing Woman AKA marusa no onna. There is a scene where one of the tax agents sarcastically ask a very rich tax evader Hideki Gondô how does one become rich. He responds with the following:

To save money, you don't spend it. It's as simple as that. You give maybe $100 at a funeral, $200 at a wedding. That's not good. A million is nothing if you spend it. But even $100 is yours if you save it. Say you're trying to fill a glass with dripping water. When it's half-full, you're thirsty, so you drink. But that's stupid. Wait until it's full. But still don't drink. Wait 'til it brims over and lick it. That way you save the water and drink.

-Hideki Gondo

The New York Times article below demonstrates that a lot of rich people did not listen to this advice.

One of the big problems is how differently people within a family spend, save and invest money that has been managed as a pool for many generations. When the credit markets froze and the stock market tumbled, not every cousin agreed to tighten his alligator-skin belt. That caused friction.

Some family members with money in individual trusts are opting to go off on their own. The bigger issue is when families have to cooperate to run the business the patriarch set up.

In the past, family businesses and family wealth were commingled. If the business was struggling, the patriarch would often finance shortfalls. “Now the kids are upset about where the money is going,” said Holly Isdale, managing director at Bessemer. “Intrafamily dynamics are playing a bigger part in decisions.”

If the family put in place a strict estate plan, the children may legally own a good portion of what the patriarch made. And now they have choices to make that may go against his wishes. “These families have recognized that autopilot is not a good strategy,” said Amelia Renkert-Thomas, a lawyer with Withers Bergman.

In a previous entry I made the observation that family and money are combined, you have a very combustible situation. And right now forest fires are breaking out left and right.

One thing the group convened by Bessemer agreed on is that their clients were hesitant to buy commercial real estate. They fear that the value of it could collapse with greater ferocity than the housing market.

The logic behind this is that with everyone cutting back — companies laying off workers, consumers watching what they buy — there is less demand for office and retail space. If leases expire and are not renewed, building owners will have trouble making their loan payments. That, in turn, will affect the investors who bought the bonds secured by this debt.

Even those real estate owners who are doing well could be hurt. “A lot of this debt is short term and it needs to be refinanced, but there is no market for that,” Ms. Isdale said. Next year and 2011 are expected to be the worst, Ms. McCarthy said.

So while the super-rich bought properties on the cheap in previous real estate downturns, they now may be struggling with the financing on the ones they own and wary to add more, even at discount prices.

I make an effort to observe rich people, not because I have a lot of money but because whatever they do has an effect on their surroundings. Right now, depending on who they are, they are the most liquid demographic in the country, yet despite rock bottom prices for commercial real estate, they are not even touching it with a ten foot pole. And their actions further confirm the reports of the imploding commercial market.

NO MORE EASY MONEY One reason for the subprime mortgage collapse was that banks gave mortgages to homebuyers without verifying their ability to repay. The super-rich had their own version of this: the signature loan.

In this case, a person’s net worth would be verified but not, say, the value of the building she was buying. The feeling was if someone was worth $1 billion, she would have no problem paying back a loan for a $100 million office tower.

This gave the super-rich access to quick financing, for both hard assets like real estate and assets like securities. “There’s a realization that we can’t borrow any more to goose our returns,” Ms. McCarthy said.

Now banks want loans secured by a verifiable asset, and the super-rich are not borrowing as much. This has translated into a more conservative approach over all.

When I read this, I was like what the hell? Why would they even get involved in signature loans? The answer of course is OPM. The reason why a lot of rich people stay rich is that they are always using someone else's money. And when you are spending someone else's money, you are not spending your own. Just like those people who bought homes they could not afford, a lot of rich people have over leveraged themselves. And with the credit markets frozen, there is no place to go to stem the bleeding.

Even those real estate owners who are doing well could be hurt. “A lot of this debt is short term and it needs to be refinanced, but there is no market for that,” Ms. Isdale said. Next year and 2011 are expected to be the worst, Ms. McCarthy said.

So while the super-rich bought properties on the cheap in previous real estate downturns, they now may be struggling with the financing on the ones they own and wary to add more, even at discount prices.

Instead, super-rich families are focused on having cash on hand. One of the other uses of signature loans had been to pay for a lifestyle. Until a few years ago, many banks advised wealthy families to have 100 percent of their wealth invested to take advantage of the high returns across asset classes. If they needed cash, they could borrow at a low rate. It was easy, until it was not.

Now this is just bats**t crazy. Even someone who just watches Suze Orman knows that you never, ever play the eggs in one basket game. You make an effort to diversify and engage in asset allocation. You always spread out your money in your investments and you always have a significant chunk of it accessible to you all times in case of emergencies. As for the rich borrowing cash for their lifestyle purposes, that is no different than people maxing out their credit cards to live beyond their means. Even if they did not use plastic, they still lived a life on credit.

Unless it is for educational or business purposes, there really is no excuse for taking out loans for living expenses when you already have the money to cover your cost of living.

I was always thought the rich, the real rich, were smarter than the average bear. Not because they were more intelligent but they had access to the best financial minds in the world who would ensure they would be protected. That is obviously not the case. I think what has really hurt the rich is the people that were supposed to help them were helping themselves.

Remember this part:

Until a few years ago, many banks advised wealthy families to have 100 percent of their wealth invested to take advantage of the high returns across asset classes. If they needed cash, they could borrow at a low rate.

This is a f**king trap and here's why.

If you plunge all their money into an asset class that gives high returns, people who facilitate those transactions get a bigger piece of the action as opposed to putting your money into a much safer asset that has a lower rate of return. It is in their best interest for you to dump all of your money into that particular asset.

As for borrowing at a low rate in order to get cash, it doesn't matter how low of rate you get, you still have to pay for the service of getting that money. Wouldn't it make more sense to use your own money that is already collecting interest in a checking savings or money market account instead of borrowing it? Of course it is hard to get access to your cash if you plunge all of it into an illiquid asset like real estate.

Staying rich is not rocket science. You live frugally, you take care of the essentials, you don't get cowed into doing things that have no ROI and you give what you can to charity. And you do not take on unnecessary debt. But it does not mean you have to lead an unhappy life.